Strong Inflows Power ETF Asset Growth

Exchange-traded-fund assets are on the rise, and price appreciation has little to do with it, according to an analysis by Standard & Poor’s.

“So far this year we’ve seen pretty broad-based flows into ETFs,” said S&P equity analyst Tom Graves. “Investors and financial advisors and money managers are increasingly looking at ETFs as a vehicle for investing.”

ETF assets rose by $87 billion in the first seven months of 2011, a 10% increase from year-end 2010, according to the National Stock Exchange. As of July 31, there were 1,123 ETF products with assets totaling $1.1 trillion.

Of the asset gains this year, S&P believes that about 71% has been due to net cash flow into ETFs, with the remainder due to higher prices for assets owned by ETFs.

ETFs are grabbing market share from mutual funds and individual securities, a trend that should continue in the year ahead, according to Graves. The trend increases the pressure on mutual fund companies and other financial service companies to offer ETF products, Graves said.

Those that do will face off against a big three of ETF providers: BlackRock, State Street and Vanguard combined control 84% of ETF assets. BlackRock has the lion’s share, at 43%, followed by State Street at 24% and Vanguard at 16%.

Yet Graves said he believes that there is still room for new entrants.

“I’ve seen ETF providers like Schwab, PIMCO and others grow assets significantly,” he said. “I think there’s been enough growth demonstrated by some of these smaller providers to provide encouragement to other parties that might come into the ETF market.”

Mutual fund companies in particular have an opportunity to leverage resources such as their distribution networks and, should they create actively managed ETFs, analytic resources.

While ETFs are grabbing market share from mutual funds, Graves is not ready to call ETFs an existential threat to the older vehicles. That’s despite ETFs’ well-publicized advantages, which include low costs, transparency, tax efficiency and intra-day trading. One reason is that mutual funds have a huge head start, said Graves. They began the year with nearly $12 trillion of assets.

Not surprisingly, Graves believes that index mutual funds have more than actively managed mutual funds to fear from ETFs, most of which are index vehicles.

“As far as index funds, I expect that ETFs will gain market share from mutual funds,” he said. “But particularly for active management, mutual funds should be the preferred choice for the foreseeable future.”

The few active ETFs available now are in areas like fixed income and currency, rather than equity, he noted.

Meanwhile, although a $1.1 trillion market averages to almost $1 billion per ETF, the assets are highly concentrated among the larger funds, according to S&P research. As of July 31, the 10 largest ETFs accounted for 36% of total ETF assets, led by State Street's SPDR S&P 500 ETF Trust and SPDR Gold Shares at $93 billion and $66 billion of assets, respectively.